T3 must focus on public

Australian Financial Review

21 October 2004

As soon as it became apparent on election night that the government would have effective control of the Senate, Finance Minister Nick Minchin pointed to the full privatisation of Telstra as a policy priority. Importantly however, he restated the government’s position that no sale would take place until an adequate sale price could be realised.

The importance of getting an adequate sale price can be seen by looking at the public’s experience with T1, the first-tranche sale of one-third of Telstra, at a price of $3.30 a share. If the proceeds had been used entirely to repay debt, the resulting interest savings since 1997 would have totalled around $4.5 billion or $1.10 a share.

Over the same period, Telstra has paid out dividends (nearly all fully-franked) with a grossed-up value of $2.35 per share, and also undertaken a share buyback with a value of around 6 cents per share. The total amount forgone by the the government is around $9.5 billion.

So, the Australian public has already lost around $5 billion from the T1 privatisation. Moreover, whereas the interest saving from repaying debt is fixed in nominal terms, Telstra’s sales, earnings and dividends have risen over time, partly in line with inflation, and partly as a result of reinvestment of retained earnings.

The loss from the T1 privatisation will only increase over time. On the government’s own estimate that Telstra’s shares are worth $5.25, the total loss can be estimated at around $3 per share or about $12 billion dollars. But this is a conservative estimate.

The second-stage privatisation, at $7.40 a share, looks a lot better. Interest savings from debt repayment initially exceeded foregone dividends and other payments to shareholders. The two amounts should be about equal in 2004-5, at a little over 40 cents per share, when franking credits and the latest share buyback are taken into account. After that, the public will probably be net losers from the sale.

In present value terms, losses from 2005-6 onwards will roughly cancel earlier gains, leaving the T2 sale broadly neutral as far as taxpayers are concerned. A far better outcome could have been achieved if Telstra’s overpriced Internet assets had been sold off during the dotcom bubble and the proceeds used to return the core business to public ownership (Foot in each camp untenable for Telstra, AFR 30 March 2000).

Even on the conservative assumption that profits and dividends will remain at their current nominal level, declining gradually in real terms, the minimum price needed for the public to break even would be $6.50 a share. And this assumes that none of the sale proceeds are dissipated in bribes to the National Party.

It is hard to see how the sale price can be increased to this level under current conditions. Private equity investors expect higher rates of return than those that holders of government bonds are willing to accept. Also, a near-monopoly like Telstra faces a range of regulatory risks that are internalised under public ownership.

Of course, if Telstra were allowd to impose substantial price increases in the markets it dominates, its sale value could be increased substantially. However, any benefits to the public from an improved sale price for Telstra would be offset by the higher charges. The deregulation of airport landing charges, immediately before the sale of Sydney’s airport set the pattern for this kind of thing.

There are more attractive options to increase the sale proceeds. The most important is to use a trade sale rather than a public float. In general, trade sale privatisations have yielded higher prices, with lower transactions costs than floats. In the present case, the trade sale would have the added bonus of a control premium for the successful buyer.

Second, if, as is generally expected, restrictions on media ownership are to be relaxed, this should be done before Telstra is sold. There are major problems with a policy framework that allows the most important regulated monopoly in the country to control a substantial media network. However, it appears inevitable that such a policy framework will emerge. The resulting increase in Telstra’s value ought to go to the Australian public rather than as a windfall profit for buyers.

Telstra cannot continue in its present limbo indefinitely. On the numbers, renationalisation is the best option, at least for the core business. But since privatisation is inevitable, we should ensure that the Australian public gets the best possible deal.

John Quiggin is an Australian Research Council
Federation Fellow in Economics and Political Science at the University of Queensland.